Shares of F5 Networks (FFIV) sold off earlier this week on news that the company is spending $670 million in cash to buy rival NGINX (it's pronounced 'engine-x').
Investors apparently weren't pleased that F5 is suspending its stock buyback program because of the NGINX deal, and that it's also now forecasting -- due to the buyback suspension and the investments F5 plans to make in NGINX -- low single-digit annual EPS growth in fiscal 2019 and fiscal 2020. That's down from a prior outlook of mid-to-high single-digit EPS growth.
This reaction feels shortsighted. Arguably, F5 should have rallied in response to the deal, which takes out a competitive threat, bolsters the company's cloud position and could meaningfully boost revenue growth in a couple years' time.
F5 has long been the top supplier of application delivery controllers (ADCs) -- they're used within data centers to do things such as balance loads between servers running the same software, set network traffic policies and accelerate the performance of certain types of traffic. The company has also rolled out a number of security products, some of which run on top of its ADCs. Its ADCs are sold both as hardware appliances and as software that can run on third-party servers, including cloud servers.
NGINX is a distributor of a popular, open-source, software platform that carries the company's name. Among other things, the platform includes ADC software, web and application server software, web application firewall (WAF) software and tools for managing programming interfaces (APIs).
For a variety of technical reasons (NGINX CEO Gus Robertson outlines some of them here), the NGINX software platform has been especially popular among cloud developers, particularly ones building apps that are broken up into microservices. On a conference call held to discuss the acquisition, F5 pointed out that the software is used by 375 million websites and "60% of the busiest 100,000 sites."
As for NGINX the company, it was said to have done $26 million in revenue last year (up 65% annually), and to have more than 1,300 customers for its subscription-based software, including some top banks, retailers and tech companies. However, with F5 promising to both integrate its many security offerings with NGINX's software and use its considerable sales and channel resources to promote it, NGINX's revenue is likely to be considerably higher in 2-to-3 years time.
And such revenue growth could do much to change the investor narrative surrounding F5, which currently trades for less than 14 times its fiscal 2020 (ends in Sep. 2020) EPS consensus and a little over 12 times its fiscal 2020 free cash flow (FCF) consensus.
Though it maintains a very high market share in the traditional enterprise ADC market, F5's product (hardware and software) revenue has stagnated in recent years. A shift in the company's sales mix towards software ADCs -- they provide less revenue than hardware ADCs, but also carry higher margins -- has played a role, but so has the adoption of NGINX and of alternative solutions delivered by cloud infrastructure providers (for example, Amazon.com's (AMZN) Elastic Load Balancing service for AWS).
While the solutions provided by cloud giants will remain a headwind, pairing NGINX with F5's existing product and distribution assets leaves the company much better-positioned to deliver meaningful revenue growth over the long run. And if F5 is able to deliver such revenue growth, it will likely be rewarded with higher multiples.
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